Don’t Let The “fear Factor” Hold You Back

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March 2006
Vol. 29 No. 6

DON'T LET THE “FEAR FACTOR” HOLD YOU BACK  . . .

 

In 2006, it's going to be a little harder for us to make money. Gasoline prices are going to continue to inch upward as China and India begin to consume more energy. The proposed new tax bill promises higher taxes on profits. The new Chairman of the Federal Reserve will probably continue to raise interest rates to ward off inflation threats. Housing is cooling off as the number of houses on the market is exploding. Speculators who bet on fast appreciation in the condo market are beginning to feel the pinch. If banks get stung badly on builder defaults, credit is going to be harder to get for entrepreneurs.

 

If we want to survive and prosper over the next few years we're all going to have to adapt to the new economic paradigm and find different ways to make money. For the past 5 years or so, buying and selling houses has been a fantastic wealth creation device for many. But, all along, there are others who have made even more by providing the financing to buyers, sellers, and those who fix up houses for resale. As banks begin to cut back on loans and to raise minimum FICO qualifying credit scores, new opportunities will arise for private lenders.

 

Learning about the way that debt and credit can be manipulated to earn high profits will enable you to make money in other areas. You'll be able to harness the work of entrepreneurs both in your local market and in other markets as well. Mortgage lenders have been doing this for years. How many mortgage payments are paid to local firms in contrast to far distant lenders? Lending money can give you a new scope of operations in locations where house profits are waning.

 

Over the past few years I've made a lot of money outside my local market by making loans to entrepreneurs in other markets. You can too. This can do a lot of things for you. First of all, you won't be hemmed in by fierce competition that might prevail in your home market. Second, you can increase the safety of your investments by diversifying into other markets. Third, Many new opportunities present themselves when you can avail yourself the insights and services of talented real estate entrepreneurs. Fourth, as a lender, you won't need to employ management to produce income. Fifth, you will be able to earn money in several markets at the same time without leaving your telephone. With so many advantages, why not do it?

 

Fear of change freezes many people. In 2005 there were massive layoffs in the software, aircraft and auto industries. Thousands of good people lost their jobs and pensions. When their industry began to lose money, their jobs disappeared. The same thing can happen in the house business. When you look around your area and see taxes being raised, businesses shutting down, and skilled workers moving out of the area to find work, that doesn't presage good times in the real estate business. It may be time to find new ways to make money, even though it means having to sell out and move, or to at least begin investing in other areas.

 

Over the span of several years, in the wake of severe budget deficits and cut backs tax increases, and a growing anti-business attitude, Californians have been departing in droves for areas that offer more opportunity. Oregon, Washington, North Carolina, Georgia, Florida, Texas, Nevada, and Arizona have been major beneficiaries of this transfer of talent, labor and capital. When they haven't relocated their families, they have relocated their money by investing in houses in those areas. This has effectively exported California's housing boom to these other States. Despite diminished opportunity, many have stayed behind because they just don't want to leave familiar sights and scenes behind and adapt to new situations. Why? They are afraid of change. They don't like to learn new ways of doing business. Until they're forced to make a change, they do nothing. All you have to do is to visit small towns everywhere to see those caught in this trap.


WHAT EVER BECAME OF THE DINOSAURS?

 

People who can't change could wind up like the dinosaurs. Dinosaurs have always been fascinating to me. They were powerful beasts, and except for other dinosaurs, they had very few competitors in their era, yet they completely disappeared from the face of the earth without a trace. What happened to wipe them out in a short period of time? Whether it was a dramatic change in their environment that cut off their food supply, or some sort of disease, they couldn't adapt to the changing world around them. Successful entrepreneurs can also be wiped out suddenly by changes in the market, or new regulations, or financing that they can't adapt to; or because they haven't established a network of entrepreneurs with whom they can cooperate to overcome problems to insure their mutual survival.

 

I recently attended a wholesaler's “boot camp” in Jackson, Mississippi. It was put on by a long time subscriber and friend, Walter Wofford, at 601-594-8300, (dirtcheaphouses.com) He's going to be a speaker at our Buy/Sell seminar in Tampa in May. I wanted a preview of what he would be covering. I got an eyeful; not only of Walter's expertise, but of the way in which he was able to work with many others to increase mutual profits and to enhance the prospects of success of all.

 

Cooperation is the key that helped humans surpass other species; but beware, it can lead to dependency and exploitation. Whether we like it or not, we're all in the food chain, and have been since the world began. At first, humans were hunter/gatherers who either found or caught the food they ate. Then they learned to join together into clans and tribes to cooperate to trap animals and keep them to be eaten later. That required that grain be grown to feed the livestock; and this required that land be set aside and protected so farmers and ranchers would have a reliable food supply. That was the tipping-point at which ownership and control of land became critical to the survival of the tribe; thus they needed soldiers to preserve and protect ownership.

 

It didn't take long for military leaders to use their forces to take control of the tribe and to impose taxes to support themselves and their armies. After a few centuries, collections of people evolved into societies who jointly elected their leaders to protect them in times of war, and to maintain the peace in between wars. Elected officials swiftly discovered that their tenure at the top of the heap depended upon how well they fulfilled their mandate. Building up a large military stand-by force and waging war now and then reassured those who elected them. During peace time, providing for the well being and security of the citizens, and creating dependency upon government guaranteed their position of power.

 

We've just heard the State of the Union Address, and apparently, nothing much has changed, politically, since that first leader got elected. Oh, we have legislators to make laws, and judges to enforce them, but we still look to leaders to protect and assure the way of life we've chosen. One of the ways they do this is by periodically leveling the playing field between the “haves” and the “have nots”. This is accomplished by regulating taxes, zoning, labor, land development, housing, education, banking, disaster control, health care, and social spending. Although we complain about government intrusion in our lives and businesses, if we were honest, we'd admit that very few entrepreneurs don't receive a lot of help from government.

 

Even the most redoubtable entrepreneurs owe their success in part to availability of credit, orderly debt and equity markets, construction of highways and roads, favorable zoning, government subsidies, and tax incentives. If you would challenge this assertion, ask yourself how much business you would do without FHA and VA loans, the Federal Reserve Board, Section-8 rentals, and low interest rates. In so many words, you're dependent upon the same government you might criticize; and will probably continue to support those in power for that reason. The question you should be asking yourself is how long you'd last if there were to be a reduction in the government services and policies you rely upon. Will you be like the dinosaurs or do you already have a plan in place to help you adapt, survive, and prosper?

 

Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.

CONTROL OF FINANCING CONTROLS PROFITS . . .

 

One afternoon recently I tried to cash a check for $7,000 at my bank.

Even though it is one of the nation's leading banks, I was unable to do this because they didn't have enough cash! They explained that a number of people had made cash withdrawals and the till was empty. Why were they short of cash? Because, while I was content to deposit money in a low-interest checking account, they were lending my funds to bank customers at more than 4 times the rate they were paying me.

 

I could have lent these funds out myself, but I wanted cash to be there when I needed it. The bank could rely on other branches to shore up their cash reserves; thus, they didn't need to set aside idle funds to maintain their own liquidity. If they ran out of money, they could borrow from the Federal Reserve Bank so long as they maintained minimum reserves, which could be in the form of U.S. Bonds; so they needed little cash at all. There's a lesson to be learned here:

 

First, if you will line up emergency operating lines of credit, you too can live with a lot less liquidity, and keep more of your cash earning high yields instead of lying fallow in bank checking accounts. Second, you can use your money to either buy and sell houses, or to lend to others. Third, if you pick and choose borrowers carefully, and secure your loans adequately, you can lend out a lot of money with very little risk of loss. Fourth, if you can use your money to help other entrepreneurs make more money, you will be able to cultivate a reliable group of borrowers who will be willing, able, and ready to share their profits with you. I saw this concept in action at Walter Wofford's boot camp.

 

It all starts with wholesalers. Wholesalers are people who can find houses that they can buy at around 50% of retail value then sell quickly with a small mark-up. As a rule the house will need some rehab to make it marketable to an owner/occupant. Once a wholesaler contracts to buy such a house, he sells it or his contract as fast as possible to someone else. This may be another wholesaler who marks it up a little more and resells it, or it may be a retailer who does the needed sprucing up to increase the value, and who then sells it to an owner occupant or another investor. At every step along the way, profit and value are added to attract another buyer.

 

Here's a pro-forma transaction: Let's say that a house that would sell for $150,000 after fix up can be bought for $80,000 cash. Wholesaler #1 marks up the property about 10% above his contract price, say $88,000. The next buyer then marks up the original price to $90,000 and makes $2000 selling to the ultimate person who will fix it up to sell in the retail market. That buyer adds about $25,000 in fix-­up expenses, bringing his cost up to $115,000. He then retails it to the owner-­occupant for $149,900. After paying out another $10,000 in commissions, closing and financing costs, he winds up with a $25,000 profit with 4 months work.

 

Thus far, all we've looked at is the way in which money was made with a house; what about the profit made with the financing? Each of the buyers and sellers will have had to pay for financing in order to make the whole process work. By enhancing the ability of the others to buy and sell by providing funding, the lender may make more money than all the players in the food chain. Let's see how much a lender who both sold houses and financed them might make:

 

He buys the contract for $88,000 from the first wholesaler. He by-passes the #2 wholesaler and immediately sells directly to the retailer. By providing financing he is able to increase the cost to the retailer from the foregoing $90,000 to $100,000. He agrees to lend the retailer $125,000 to buy and fix up the house with $5000 down and $4167 interest (10%) callable in 120 days. The retailer can still make $15,000 after selling costs. Making $12,000 in a matter of days on the financier's $88,000 purchase is great, but the joker in the deck is that he discounts the loan at settlement to an investor for $120,000 and makes a $7,000 profit without using any of his funds. The investor's profit would be $9167 ($5000 loan discount and $4167 interest). That boils down to a return of 23% per year.



HIGH, SAFE YIELDS ATTRACT INVESTORS . . .

 

In the foregoing illustration, the financial entrepreneur earned $7,000 by being able to structure financing so that everyone was well paid for their efforts. He created a market for the house by lending buyers enough to buy, fix it up, and sell the house he bought. Everyone was in a highly leveraged position that was paid off by the Note-buyer. For providing “take out” funding, he was rewarded with a very high yield on a Note secured by a first mortgage.

 

The question arises, suppose the retailer failed to repay the loan and the house was foreclosed; what would the result have been? Because the loan was based upon the “fixed-up” value of the house, it would have to have been secured by extra collateral. This could have been in the form of a guarantee by the entrepreneur, or by other property acceptable to the investor. Naturally, all documentation, title work, appraisals and borrower's credit score would have to meet normal loan underwriting standards.

 

The loan proceeds would be distributed on a “draw” basis as the work progressed. If work stopped, so would loan draw-downs. If the house had to be foreclosed, either all the money advanced would have been recovered at sale, or the lender would have been the new owner of the house. As a practical matter, the entrepreneur who engineered this transaction could resell it to another retailer who would complete the job; or he could step in and take title to the house while continuing to rehab it for sale.

 

If he undertook to complete the house himself, he'd pick up the retailer's $15,000 profit in addition to all the rehab that had been previously performed. To his prior $7,000 profit that he'd already received, he'd be able to add $15,000 more profit within 120 days. Meanwhile, this would have been 100% leveraged with the funds from the investor's Note purchase that was used to pay the other parties.

 

In some areas, foreclosure is a lengthy process that can take a lot of time. During this period, the lender's money could be tied up, preventing him from making more loans to you. One way to reduce this problem is to get the borrower to form a Limited Liability Company into which he'd place the property. The loan would be made to the LLC, to be secured both by an assignment of 100% of its shares as well as the property itself. Recording a mortgage on the property would protect it from mechanic, material, judgment liens. The promissory note signed by the retailer would contain a schedule of work to be done within certain time periods. Failure to complete the work would constitute default on the Note. Now, should a default in performance occur, the LLC shares could be “repossessed” under the provisions of the Uniform Commercial Code (UCC) without the necessity of going through foreclosure. All required conveyances could be done by the LLC under the control of the lender. Going the extra step to secure these loans will go a long way to attracting lenders.

 

Assuming that there is a wholesale and retail market in your area, finding an investor with enough money to fund this kind of transaction would seem to be the hardest part of the process. Believe me, when 20%+ secured yields are on the table, there are plenty of investors who are willing, able, and ready to participate. A natural investor is a tax-free pension plan or self-directed IRA. There's nothing quite like being able to have your money earn high yields tax-free. If you could keep your money working to earn 20% per year, your IRA balance would double in a little under 4 years with little effort on your part.

 

What about those who don't have an IRA, or who don't have enough money in it to play in such a big game? There are several things you can do. One of them is to form a Trust with other IRAs and combine resources to make these loans. The other is to borrow IRA money that is being held in low-paying investments and re-­lend it to entrepreneurs. Isn't this exactly what the banks have been doing with the money you've let languish in low yield accounts? The bottom line is that entrepreneurs will search you out once they discover that you've got money to lend; whether it's your own, or borrowed from others.

 Copyright © Sunjon Trust All Rights Reserved, www.CashFlowDepot.com. (888) 282-1882
Quotation not permitted.  Material may not be reproduced in whole or part in any form whatsoever.

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